Monetary Policy and Price Stability in Nigeria (December, 2006 Through February, 2012).
ABSTRACT
This research work evaluates the responses of inflation, interest and exchange rate to shocks in Monetary Policy (captured by MPR) as well as the impacts of MPR on these Macroeconomic Variables.
The study used monthly data spanning from December, 2006 (when the MPR was introduced) through February, 2012. Following Joao and Andrea (2006), the research used Structural VAR to estimate the model.
The result shows that inflation responds to shocks in MPR only in a fairly unstable manner (a pattern that is almost unpredictable); in the first four periods, positive shocks in MPR could not bring down inflation but thereafter, any further increase in MPR produced gradually declining but positive rate of interest.
On the other hand, exchange rate responds to shocks in MPR in a relatively downward fashion and quickly assumes upward trend from the second period lasting throughout the period, while interest rate, responds quickly and positively to shocks in MPR from the first thorough the last period.
Therefore, interest and exchange rates are more responsive to shocks in MPR than inflation and above all sometimes changes in MPR cannot guarantee the expected changes in Inflation (because of large informal sector as well as policy divergence between the monetary and fiscal authorities among other reasons).
Hence, of all the three variables, inflation is the most difficult to deal with and stability of which is a necessary condition for the achievement of stability in the other two variables (interest & exchange rates).
More so, interest and exchange rates as well as MPC meetings are better predictors of MPR (because of their high sensitivity to it) than the rate of inflation.
The result also uncovered that as the most difficult enemy of the economy, inflation cannot be effectively and efficiently conquered with the variation in MPR alone, other instruments particularly Cash Reserve Requirement (CRR) and especially Open Market Operations (OMO) should be prudently used to compliment the efficacy of MPR.
Consequently, the paper further recommends the current monetary tightening stance of CBN but should be used with caution, improvement and expansion of the cash-lite policy and non-interest banking of the CBN, infrastructural development, harmonization of fiscal and monetary policy as well as the reduction in the number of MPC meetings to at most quarterly unless in case of emergency.
TABLE OF CONTENT
- Background of the Study…. 1
- Problem Statement………… 2
- Research Questions………. 4
- Objectives of the Study……. 4
- Justification of the Study……. 5
- Hypothesis………………. 6
- Scope………… 7
- Limitations of Study……… 7
- Literature Review……… 9
- Conceptual Literature…… 9
- Overview of Inflation………….. 9
- Monetary Policy and Inflation in Nigeria….. 14
- Overview of Exchange Rate…………. 15
- Exchange Rate Management in Nigeria…… 16
- Problem with the Nigerian Exchange Rate System……….. 17
- Inflation and Exchange Rate…….. 19
- Monetary Policy and Exchange Rate….. 19
- Overview of Interest Rate…… 20
- Interest Rate Management……….. 21
- Interest Rate Management Techniques…… 22
- Interest and Exchange Rates……….. 22
- Interest and Inflation……. 23
- Monetary Policy and Interest Rate……………. 24
- Inflation, Interest and Exchange rate (Macroeconomic) Stability….. 24
- Definition of very important Terminologies (VIT)…… 26
- Theoretical Literature……. 29
- The Monetarist Theory………. 29
- Keynesian Liquidity Theory of Interest…. 30
- Purchasing Power Parity (PPP) Theory……… 33
- Interest Rate Parity Theory……. 34
2.6.0 Empirical Literature………. 34
3.1.0 Methodology; introduction………. 38
3.2.0 Sources of Data…… 38
3.3.0 Model Specification…. 38
- Estimation Techniques……. 39
- Unit Root Test……….. 39
- Granger Causality Test…………. 40
- Impulse Response Function……. 40
- Variance Decomposition……………. 41
- 0.0 Analysis of the Result……….. 42
4.1.0 Unit Root Test…… 42
4.2.0 Granger Causality Test………. 42
4.3.0 Impulse Response Function…. 44
4.4.0 Variance Decomposition………. 49
5.0.0 Summary, Conclusion and Recommendations……. 51
5.1.0 Summary……… 51
5.2.0 Outline of Findings.. 51
5.3.0 Conclusion………… 52
5.4.0 Recommendation……. 52
5.5.0 Future Directions of Research……… 54
Reference 55
INTRODUCTION
1.1 Background of the Study
Economic literatures vindicated that price stability could be achieved through monetary or fiscal policy or an appropriate combinations of the two (CBN, 2012; Idowu, 2010).
Fiscal policy is a policy under which the Government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment.
The Monetary policy on the other hand refers to the specific actions taken by the Central Bank to regulate the value, supply and cost of money in the economy with a view to achieving Government’s macroeconomic objectives (CBN, 2012).
For many countries like Nigeria, these objectives are explicitly stated in the laws establishing the central bank, while for others they are not. In Nigeria, the major objectives of monetary policy are the attainment of price stability and sustainable economic growth (Sanusi, 2012).
Associated objectives are those of full employment, stable long-term interest rates and real exchange rates. In pursuing these objectives, the CBN recognises the existence of conflicts among the objectives necessitating at some points some sort of trade-offs (Uchendu, 2010).
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